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Home , Capital and Interest, Don Lavoie, Gary North (economist), Israel Kirzner, Ludwig Lachmann, Ludwig von Mises

A Roundabout Approach to Macroeconomics 2

another matter. Here, the time element is a debilitating problem: These expectations, if you can call them that, are baseless. The future is shrouded in an impenetrable fog of uncertainty, leaving the current level of investment spending to be determined by unruly psychological factors—Keynes’s infamous “animal spirits.” The resultant circular flow will gush and ebb and even on average may not entail enough flow to fully employ the labor force. The circular-flow framework, exercised in both its short-run and long-run modes, seems to me to be exactly the wrong framework for understanding and dealing with the A Roundabout Approach to Macroeconomics: time element in macroeconomics. Identifying the polar cases of “no problem” and Some Autobiographical Reflections* “debilitating problem” doesn’t get us any closer to a solution to all those intermediate cases lying between the poles. The tell-tale feature that inevitably characterizes this framework has been recognized in recent years by (1997)—namely the Roger W. Garrison** lack of any “real coupling” (Solow’s term) between the short run and the long run. In Solow’s reckoning, the two runs simply divide our discipline’s subject matter into (1) the problem of maintaining full employment of existing resources and (2) the I. Introduction: Setting the Stage determinants of economic growth. “” is a concept featured in Austrian theory. Homely stories A viable alternative to the Keynesian circular flow framework is the Austrian about the bare-handed catching of fish are a prelude to a discussion of the economy’s means-ends framework. People employ means (investment) to achieve ends capital structure. The outputs of some stages of production become inputs to others. (). In a capital-using economy, there is a significant time dimension Production takes time. The capital structure, broadly conceived, has a temporal separating means and ends. We realize that some production processes take more time profile—one that can be modified in response to changes in intertemporal consumption than others. And, thinking in macroeconomic terms, we recognize that production time preferences and resource constraints. This was the central message of Eugen von can increase or decrease for the economy as a whole as conditions warrant. In Böhm-Bawerk (1959). the “medium run” (a term from Solow, 2000), the problem is one of adjusting , who theorized in terms of the short period and the long period, production decisions to (intertemporal) consumption preferences—a problem that Axel taught us that most problems in economics stem from the ever-critical time element. Leijonhufvud (1998) urges us to put back on our macroeconomic agenda. The only I think Marshall was right on time. But I also believe that a healthy understanding of solution available in a decentralized economy is one involving entrepreneurial some of those problems, particularly the ones in macroeconomics, is not best facilitated responses to changing market signals and especially to changes in the rate of . by his simple short-period/long-period distinction. The time element here (Böhm-Bawerk’s “roundaboutness” of production activities) is Adopting Marshallian methods, dealt with the polar a key variable in the system. Like other endogenous variables, it is subject to marginal extremes in the quality of expectations, casting serious doubt about the viability of a adjustments in response to parametric changes. Of course, there is uncertainty. And the market system. In the short run, the time element itself is no problem: Short-run fog is more of a problem the farther into the future the entrepreneurs are trying to see. expectations faithfully reflect reality. If the level of spending changes, the multiplier But still, what seems to be called for is an application of and not a process plays itself out in a clockwork sequence of spending and earning, eventually contrasting of the polar cases. achieving a new circular-flow equilibrium. Long-run expectations, however, are At the very dawn of the Keynesian , the circular-flow framework and the means-ends framework were seen as the two real live alternatives (Hicks, 1967). Marshall-cum-Keynes gets you one vision of the economy (plus a toolkit of policy * Forthcoming in The American , vol. 47, no. 2 (Fall) 2004. Also in Michael Szenberg and options); Böhm-Bawerk-cum-Hayek gets you another vision of the economy. In the Lull Ramrattan, eds., Reflections of Eminent , Brookfield, VT: Edward Elgar, 2004. early 1930s, Friedrich A. Hayek was brought to the School of Economics by Lionel Robbins precisely for the purpose of providing a counter to the ideas of Keynes. **Roger W. Garrison is Professor of Economics at Auburn University in Alabama and author of Time But Hayekian ideas proved ineffective against the Keynesian avalanche. Debate and : The Macroeconomics of Capital Structure (, 2001). Some material for this essay is drawn from the Preface of Time and Money and from Garrison (1995a) and Garrison (2000). continues to this day about just why Hayek failed to review the General Theory 3 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 4

(Caldwell, 1998) and just how he lost out to Keynes. capacitors, I was off to the supply room. It was a rude awakening—to say nothing of At mid century, Hayek’s cycle theory, a theory that contained the seeds the embarrassment—to learn that a 30-farad capacitor would be about the size of a of a full-fledged capital-based macroeconomic framework, had sunk into oblivion. His boxcar! books, including Prices and Production, which was the print version of the lectures he When I eventually acknowledged the constraints imposed by reality and could had delivered at LSE in 1931, were long out of print. Undergraduates of my actually get the raw materials for a circuit, I had no trouble putting them all generation—even economics majors—would never hear about Hayek, much less learn together—but only if the other students would leave me alone. Which is to say that I that his theory was once the principal rival of Keynes’s. The index in ’s was no good at team work. Unfortunately, we usually had six hands working on one Principles of Economics, 7th ed. (1967), which dominated the field at the time, refers circuit. That was an exercise in frustration for me. Things were no better in the the reader to a single footnote in an appendix on commodity and factor pricing—where heavy-machinery lab, where we had only three hands working on the circuit. As a Hayek is portrayed, in effect, as being on the losing side of the socialist-calculation not-too-subtle safety reminder, the lab instructor had left one pair of sneakers welded debate. to the floor—a result of an earlier student completing the circuit in an all-too-personal Prices and Production didn’t get back into print until 1967, when it was offered, way. Each of us had to work with one hand behind his back. And by the way, “behind along with other Hayek books, by Augustus M. Kelley as part of a reprint series. But her back” is a phrase that had little application at Rolla in the 1960s. The female in that year, I was a long way from reading Hayek and, in fact, a long way from population at the Missouri School of Mines could have been measured in picofarads. studying economics. The progression of my own studies from the sinusoidal rhythms Whether involving effort or team effort, the technical courses at MSM of alternating current to the cyclical fluctuations of a was a roundabout were given precedence over other courses—few in number—that were outside the hard one—hence the double entendre of this essay’s title. sciences. I took a one-semester course in economics (both micro and macro) to fulfill the social-science requirement. I remember the Keynesian diagrammatics and II. Flashback: Electrical Engineering and Engineering Econ remember thinking that Samuelson’s rendition of the circular-flow, complete with In January of 1967 I was completing the course requirements for a BS in Electrical small drain spout that vented saving away from the investment pump, had something Engineering. Few students could finish the course work in four years at the Missouri of a comic-book character to it. Neither the diagram nor the text inspired careful study School of Mines and Metallurgy (now the University of Missouri at Rolla). Most took of Keynes, and there was no hint of a more appealing alternative. The lectures on five years. I was lucky to get through in four-and-a-half—especially in view of my unemployment and business cycles were no help. I remember only that the professor having completed the first two years at a junior college. Getting some early course ended almost every sentence with the words “as such.” And sometimes there were two work behind me at Joplin Junior College kept the cost of my education down. I could back-to-back “as suches”—one deliberate, one subconscious. live at home and cover the out-of-pocket expenses with income from part-time and The only other course that had any economics content at all was taught in the civil summer jobs. The junior college put me a little behind in terms of the applied engineering department. It was called Engineering Economics—with the Economics engineering courses, but it put me way ahead in terms of mathematical skills. Martha always pronounced with a long e and usually shortened to “Econ.” I look back at that McCormick was probably the best college-level professor of mathematics in the state. course now with both amusement and gratitude. What does a professor of Engineering Partly because of McCormick, along with some excellent junior high and high Econ do with a bunch of students who (1) have highly honed math skills but (2) have school math teachers, mathematics was my strong suit. But it was McCormick herself little or no appreciation for the economic aspects of engineering? The answer: Confront who steered me away from it. At the time, she knew more economics than I did. She them with a bunch of present- problems in which the inputs and the outputs are knew that even an advanced math degree did not translate into attractive employment described by high-order polynomials or by transcendental functions of one sort or opportunities. Her suggested alternative was an applied field—engineering. She another. Then, award them an A if they can do the math. The professor in that course suggested electrical engineering because that specialty made use of the most played right into my hands. sophisticated mathematical techniques. I do remember noticing that in many of the problems the interest rate was given. I was very good at textbook engineering but was a virtual non-starter in the I wondered just who gave it in the real world, but it never occurred to me to ask. The electronics labs. Given some output specifications, I could design a circuit and professor didn’t so much as hint that there were important issues here. If the rate of determine the power requirements and the parametric values of all the elements and interest reflects the give and take of the marketplace, the resulting resource allocations active components with ease—so many ohms here, so many farads there, and so many will have a certain internal consistency about them. But if the interest rate is given watts. If my calculations called for a few 500-ohm resistors and a couple of 30-farad from on high by the policy committee of the central bank, the internal consistency is 5 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 6 in doubt and the economy may be moving along an unsustainable growth path. These efficient than the more conventional homes that used both electricity and natural gas. issues were well beyond the scope of Engineering Econ. A low rate of interest favored the all-electric option because of its large up-front I also recall that in some of the problems, the internal rate of return had to be insulation costs. determined. And for problems in which the given time profiles of outlays and revenues After graduating from the Missouri School of Mines, neither my work experiences overlapped, there was an obvious possibility of multiple internal rates of return. It nor my one interview trip (to IBM in Poughkeepsie, ) counted for anything. could turn out that the internal rates for such a project were 8% and 2%. Not much was The Vietnam war was in full swing, and I was registered at one of Missouri’s more made of such cases. But when I learned years-and-a-career-change later of the related draconian draft boards. My older brother (and only sibling) had received his draft possibility of “technique reswitching” and of the so-called Cambridge capital notice just before graduating from the Kansas City Art Institute. Jim was in a training controversy, I found the phenomenon less than earth-shaking and the controversy trajectory that would eventually land him in Vietnam. My options were limited. MSM almost wholly sterile. in the 1960s was no Berkeley. Engineering students tended to be neither protesters nor Piero Sraffa (1960) had laid the groundwork in a book that he wrote in the 1920s draft dodgers. But many of them, including me, were risk minimizers. I chose to take but published decades later. Paul Samuelson offered a summing-up article in 1966: The a commission in the Air Force, preferring four years in that branch of the service to relative profitabilities of two techniques (A and B) could change and then change back two years in the Army. On receiving the commission in San Antonio, Texas in April as the interest rate underwent a continuous decline. That is, during the decline, a of 1967, I was assigned to an electronics-countermeasures lab at Griffiss AFB in -maximizing producer would switch from A to B and then back to A. The math Rome, New York. I became a systems engineer, traveling to Texas, California, and was the same as in the case of multiple rates of return: Set the present values of the two elsewhere in the continental US to monitor contracts for the development of techniques equal to one another to find the two rates—maybe that same 8% and radar-jamming systems and the like. 2%—where the switching and reswitching take place. One technique is the more At Griffiss there was some in-house capability, including a state-of-the-art profitable between the switch and reswitch points; the other is the more profitable at mainframe computer. General Electric was still in the process of debugging the new all other rates. It’s Engineering Econ. But the very possibility of technique reswitching, computer and hence invited the researchers at Griffiss to use it for any and all purposes according to the Sraffians, casts grave doubts on the logical integrity of the in order to identify still more bugs. Computer time became a free good, and given the neoclassical production function and on the validity of Böhm-Bawerk’s capital theory. demands of the limited war on military personnel in the Mohawk Valley, I had plenty Eventually, Joan Robinson (1975) wrote an article on “The Unimportance of of free time to exercise the computer. On my own I decided to learn to program in Reswitching”; Cohen and Harcourt (2003), who have recently wondered out loud BASIC, which at the time was a new computer language. I was motivated by my interest “Whatever Happened to the Cambridge Capital Theory Controversies” still see deep in mathematical puzzles. An article on BASIC in Aviation Week, a very popular and unresolved issues here. My own take on the controversy appears as “Waiting in magazine at Air Force labs, claimed that the new language deserved credit for its user Vienna” (1979). friendliness, but that it was not at all adept at “problem recognition.” For instance, BASIC could never be used, according to the article, to solve the problem known as the III. Disrupting Events and Changing “Knight’s Tour of the Board.” During the summers of my undergraduate years, I had work experiences that gave me I had never heard of the Knight’s Tour, but my AW-reading colleagues had. They a taste of the real world of engineering. I worked one summer for the Eagle Picher explained that the Knight must move around the chess board, starting where a Knight in Galena, Kansas. The Galena facility, located along a stretch of the original always starts, moving like a Knight always moves, and landing on each square once Route 66, processed lead and zinc for the company’s battery division. The work there and only once. It sounded like a challenge. Could I write a program in BASIC to was a little too real-world for me. I don’t think I would have made a very good generate a successful Knight’s Tour? My attempt at a solution was literally my first production engineer. program in BASIC. Undoubtedly I produced a very inefficient and graceless piece of I worked another summer for the Kansas City Power and Light Company. There programming. But I had the compensating advantage of unlimited computer time. I I learned first-hand about the perversities of rate-of-return regulation that had recently could set the program to running late on a Friday afternoon and return on Monday been dubbed the Averch-Johnson effect. This form of regulation creates incentives for morning to see if a solution had emerged from my remote consol. Eventually, one did. the firm to pad its capital base so that higher total profits fall within the allowed rate The computer typed out an eight-by-eight matrix of numbers from 1 through 64, of return. Most of my time at KCPL was spent doing Engineering Econ—using showing the trail of a successful tour. I streamlined the program and was able to get a present-value calculations to show that a well-insulated all-electric home is more cost solution in five-to-fifteen minutes. Before I grew tired of this puzzle, my program 7 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 8 found some twenty-odd solutions, never finding the same one twice. And it found one significance because of my awareness of the lingering effects of the solution where the Knight’s 64th position was within a Knight’s move of its initial on my family. My parents were just reaching adulthood when the depression came. position—closing the path and giving me a Knight’s Tour from any starting point. I Their experiences in coping with deprivation during the 1930s set their attitudes about don’t know what the state of knowledge of the Knight’s Tour was at the time, although economic matters for life. They strongly distrusted banks, but they were always big the Aviation Week article indicated that there were only a handful of solutions. I never savers—even though there was little income out of which to save. A large portion of tried to publish the program to demonstrate the “problem-recognition” qualities of my extended family (mostly on my mother’s side) left Missouri in the 1940s and 1950s basic. For me solving a puzzle was an end in itself and a good way to deal with too for California. (The economywide depression had gotten compounded in southwest much time. Missouri by the depletion of quality ore in Missouri's lead belt.) I remember hearing Less than a year after I began my own four-year tour, Jim got orders sending him an older cousin quip that many in our family were so poor they had nothing to lose by to Vietnam. He departed from an Army post in North Carolina, stopping in the starting over in California and that the rest were so poor they couldn’t afford the trip! Mohawk Valley before heading to the west coast and then to the war zone in Southeast There was no coherence in political attitudes in my extended family—my father’s Asia. His diversion from Army life had consisted of reading . Having read family being Republican and my mother’s family Democratic. I remember an aunt a few of her books, he asked me to find and send him the others. Shortly after his expressing her political views in an impish ungrammatical sing-song fashion: departure, I found a bookstore in Syracuse that carried all of Rand’s books—her novels “Roosevelt was for poor people; I’m a poor people; so I was for Roosevelt.” But I also and her collected essays on the of . I bought two of each. Over remember the contempt in my father’s voice when he recited the campaign slogan that the following weeks, I would send Jim a Rand book and then read the copy I’d bought had emerged in Roosevelt’s 1936 reelection campaign: SPEND, SPEND, SPEND; ELECT, for myself. ELECT, ELECT! Objectivism is strong medicine, especially for people with a background in In my immediate family, my father’s political gene was dominant. My mother engineering. I had spent my college years avoiding courses in the social sciences showed no signs of a cross-party marriage and even did duty, along with my father, as because of the apparent lack of structure and reason. But Rand’s : the a grass-roots committee chairperson for the Republicans. They were comfortably on Unknown Ideal (1967) was full of structure and reason, and it provided a moral the right side of the issues of the day—but not on the religious right. In fact, my foundation for a free . This collection of essays by Rand and others came with father’s Ayn Rand was Robert Ingersoll, a prominent nineteenth-century free thinker. a list of recommended readings, including a number of books on economics. Rand The touchstone for my parents’ was self reliance. In my father’s eyes, identified the economists of the as the most capable of showing just personified the party’s ideals. what is—or ought to be—sitting on her philosophical foundation. I soon discovered I began reading from Rand’s list of recommended books and soon came across that Austrian economics is appealing to an engineering mind: basic principles, -like America’s Great Depression (1963) by , another erstwhile member propositions, unequivocal conclusions—all grounded in and applicable to the of Rand’s inner circle. I found Rothbard’s account of boom and bust compelling and world as we know it. Among the authors flagged for further study were Eugen von especially significant in light of the stark contrast between the views of the Austrian Böhm-Bawerk and as well as such popularizers as Frederic Bastiat economists and those of my engineering cohorts. With a monopoly on money creation, and . the could artificially cheapen credit and orchestrate an economic The Rand volume itself contained two articles by Alan Greenspan, one exposing expansion—an artificial expansion that eventually and inevitably would collapse. the fallacies of “Antitrust,” the other establishing the connection between “Gold and Policies commonly defended in the name of stability and growth led instead to Economic .” And in an article by Nathaniel Branden dealing with the instability and decay. In later years, I would attach even more significance to this view economics of depression, a memorable metaphor was attributed to Greenspan: Putting of boom and bust—when I compared it to the curious and implausible accounts of the the government in charge of the money supply is like putting a penny in the fuse box. business cycles offered by other schools of thought. As recounted in a recent biography by Justin Martin (2000), Alan Greenspan was a During the second half of my military career, I immersed myself in member of Ayn Rand’s inner circle. economics—Austrian and otherwise. My brother had returned safely from Vietnam All this was heady stuff to me. Just what was the role of gold in the economy? and regained his status as a civilian. He was beginning a career in graphic design in And what was the purpose of a central bank? Were depressions inherent in the nature . We had a number of opportunities to bounce ideas off one another, of a , or were they the result of ill-conceived stabilization policy? For and on a couple of occasions, we met in Boston to hear Ayn Rand’s annual Ford Hall me, these questions had the makings of a new puzzle. And this puzzle had a special Forum Lecture. 9 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 10

Though I was sympathetic to Rand’s philosophy, I felt that I might actually have Aerospace in terms of the difficulty of making the transition from guns to butter. An something to contribute on the economics front. The puzzles of boom and bust had an electrical engineer with four-years’ experience in warfare electronics could not enduring appeal. Times were good in the 1920s and bad in the 1930s. How could times compete effectively with an entry-level applicant with a fresh degree. One option in general be either good or bad, and just what made them so? I jumped into the middle popular among my peers was to work on an MBA degree while waiting for better of the ongoing battle of ideas by reading Henry Hazlitt’s Failure of the “New times. An EE/MBA was considered to be a very marketable combination. I chose to Economics” (1959). The first few chapters of this critique of Keynes’s General Theory pursue a masters in economics instead, knowing that the course work would be more (1936) were enough to persuade me that I could not read Hazlitt’s book with profit interesting and thinking (erroneously) that an EE/MA combination would also be unless I first read Keynes’s. I had no idea at the time what actually lay in store for me. marketable. I applied for admission into the masters program at the University of In his own preface, Keynes does warn the reader that his arguments are aimed at Missouri at Kansas City. Attempting to compensate for having very little formal his fellow economists, but he invites interested others to eavesdrop. As it turned out, undergraduate training in economics, I attached to my application a list of books I had even the most careful reading of the General Theory’s 384 pages and the most intense read in preparation for graduate school. The books ranged from Ludwig von Mises’s pondering of its one solitary diagram were not enough to elevate me much beyond the Theory of Money and Credit (1912) to Shirley Schiebla’s Poverty is Where the Money status of eavesdropper. But Keynes made me feel that I was listening in on something Is (1968). It is a wonder that I was admitted into the program. important and mysterious. The ideas that investment is governed by “animal spirits” At UMKC the most revered economists were the Institutionalists—Thorstein and that the use of savings is constricted by the “fetish of liquidity” do not integrate Veblen and Clarence Ayers. But the courses in macroeconomics offered a heavy doses well with more sympathetic treatments of the free-enterprise system. Keynes’s notion of Keynesianism. Direct references to Keynes’s General Theory, however, were rare. that the rate of interest could and should be driven to zero seemed puzzling, and his Instead, his analytical framework was presented in the conventional form of IS-LM call for a “comprehensive socialization of investment” served as a red flag in more analysis, those interlocking diagrams that jointly determine the equilibrium values for ways than one. the economy’s income and its interest rate. Gardner Ackley’s Macroeconomic Theory With Keynes’s mode of argument—though not the full logic of his system—fresh (1961) was the assigned text. The substantial investment involved in mastering the in my mind, Hazlitt’s book was intelligible, but his virtual page-by-page critique came diagrammatical technique seemed to give professors and students alike a special across as the work of an unreceptive and hostile eavesdropper. Keynes”s vision of the interest in defending Keynesian views. Further, the only alternative mentioned was the macroeconomy—in which the market tends toward depression and instability and in trumped-up classical model devised by Ackley himself as a foil for understanding and which the government assumes the role of stimulating and stabilizing it until social appreciating the revolutionary character of the Keynesian system. reform can replace it with something better—was never effectively countered. Not I vividly remember reporting to my brother on the state of macroeconomic surprisingly, Hazlitt did point to the Austrian economists as the ones offering the most pedagogy. I explained how the Keynesians had a virtual lock on macroeconomics. The worthy alternative vision. There were a double handful of references to Hayek’s interlocking graphics yielded up answers to macroeconomic questions, and if the writings and twice that many to Mises’s. students didn’t give those answers, they had no answers at all to give. Hayek was a After a diet of Keynes, contra-Keynes, and then Austrian economics, I returned genuine alternative to Keynes in the 1930s. Forty years later there was a glaring need, to my old principles text to see how I had failed to come to any understanding at all Jim and I agreed, for a genuine alternative to the Keynesian graphics. during my undergraduate experience with macroeconomics. In Samuelson’s chapters In late 1972 I began to devise an Austrian counterpart to the Keynesian diagrams. on the macroeconomy, I found a total eclipse of the most fundamental issues. The Rothbard’s Man, Economy, and State (1962) provided the primary source material. In questions of whether, how, and in what institutional settings a market economy can be the end, I was able to draw together individual diagrams taken from or inspired by self-regulating were crowded out by a strong presumption that self regulation is not Rothbard, Mises, Hayek, Böhm-Bawerk and Wicksell and show that they all fit possible. The vision of an economy adrift was reinforced by simplistic exercises together into a coherent story about boom and bust. I wrote a term paper titled showing how in a failure-prone circular flow the extent of labor and resource idleness “Austrian Macroeconomics: A Diagrammatical Exposition.” My graphics were is related to the leakages from (and injections into) the economy’s streams of spending. three-dimensional: the Austrian view was represented in one plane, the Keynesian view in another, orthogonal plane. This construction allowed me to show the definitional IV. From Engineering to Economics connections between the two views as well as the key substantive differences. The engineering market was glutted in 1971 when Vietnam was winding down and I The professor gave me a high mark on the paper but confessed that he hadn’t was making my exit from the military. Electrical Engineering was second only to actually worked through the graphical analysis and wasn’t familiar with Austrian 11 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 12 economics. To my surprise, though, he offered to arrange for me to present the paper Lachmann gave lectures dealing with method, theory, and policy, all published in due at the Midwest Economic Association meetings to be held in Chicago in April 1973. course as The Foundations of Modern Austrian Economics (Dolan, ed., 1976). Henry With some urging from this professor, I agreed to go to Chicago. I soon realized, Hazlitt and Bill Hutt added much insight and perspective to the discussions. Milton however, that neither he nor anyone else had provided me with critical feedback. No Friedman was there for the opening banquet. His now-famous remark that “there is no one had actually read the paper. And I was to present it to a professional audience in Austrian economics—only good economics and bad economics” had a certain (but April! The one action item that occurred to me was to send the paper to Rothbard. unintended) galvanizing effect on the conference. The list of participants, most meeting Maybe he would respond in time to give me some confidence about Chicago—or to one another for the first time, now reads like a Who’s Who in Austrian Economics: allow me to renege on my agreement to go. Dom Armentano, , John Blundell, , David Henderson, About a week after mailing the paper, I got a phone call from Rothbard. He was Jack High, Randall Holcombe, , Larry Moss, , Gerald clearly enthused about the diagrammatical exposition; he saw it as beating the O’Driscoll, Mario Rizzo, Joe Salerno, Sudha Shenoy, Karen Vaughn. One purpose of Keynesians at their own game. “Would you be coming to New York anytime soon?” that conference was to persuade Lachmann that there was sufficient interest in Austrian he asked. Although I had no plans whatever to go to New York, I managed to economics to justify his coming out of semi-retirement and teaching at New York announce: “I’ll be there during spring break,” at which point he invited me for dinner University. By week’s end, the interest was not in doubt, and Lachmann soon began and further discussion of the diagrams. teaching at NYU. Dining with Murray and Joey Rothbard in their book-lined upper westside There were two follow-on conferences held in successive years—with Hayek apartment was a pleasant and memorable experience. After dinner more guests arrived joining the original South Royalton faculty. In 1975 the Austrians met at the University for a lively discussion of the paper. There were lots of good suggestions for revision of Hartford in Connecticut; in 1976 they met in at Windsor Castle. At both and further development. In the short period between my March trip to New York and conferences, papers by South Royalton participants were presented and discussed. The the April meeting in Chicago, I was able to make some improvements and gain some Windsor Castle papers, among which was my newly revised “Austrian confidence. Macroeconomics,” were eventually published as New Directions in Austrian The presentation in Chicago was a virtual non-event, which, as I soon learned, is Economics (Spadaro, ed., 1978). My diagrammatical exposition has had a limited but typical of sessions at professional meetings. But that disappointment was enduring success. It was published separately as a monograph by IHS and was overshadowed by the fact that Rothbard had invited me to attend a week-long excerpted extensively in Duncan Reekie’s Markets, Entrepreneurs and : An conference on twentieth-century American sponsored by the Institute Austrian View of Capitalism (1984). It continues to appear on Austrian economics for Humane Studies and scheduled in the summer at Cornell University. He and Forrest reading lists, was the basis for some discussion in an interview published in Snowdon McDonald (now of the University of Alabama) were to lecture for a week to an et al. (1994), and tends to get mentioned in histories of the Austrian school, such as in audience consisting mainly of student historians. Vaughn (1994), and in survey articles, such as in Kirzner (1997). With that conference, which came at the end of my studies at UMKC, I became comfortable with the fact that I had left engineering forever. I had spent the summer V. Interlude: The Federal Reserve of 1972 (the Watergate summer) as an intern at the Bureau of Labor Statistics in Spending time at the Federal Reserve was an important part of my education. But apart Washington D.C. But on finishing the course work for the masters degree, I applied for from occasionally being on “burn detail”—destroying soiled or torn —I was employment in engineering as well as in economics. In the same week, I had not directly involved with monetary matters. I was in the Division of Bank Supervision interviews with the Bendix and with the Federal Reserve Bank of Kansas and Structure, where applications for the acquisition of banks by bank holding City. I discovered that an MA in economics was a poor substitute for an MBA in the were processed. In play here were the issues of industrial organization. The eyes of engineering firms. With some philosophical reservations, I accepted the job at Federal Reserve, in effect, was serving as trust buster for the banking industry. The the Kansas City Fed, delaying my start date until after the Cornell conference. I learned focus in each case was on market share—although there was no benchmark market much from the Rothbard-McDonald lectures, but more importantly, my name was share according to which some actual market share could be judged harmless or added to the invitation list for subsequent conferences. worrisome. And the numbers quantifying the change in market share were very In June of the following year (1974) I spent a week at South Royalton, sensitive to the definition of the market area, a definition that itself was almost wholly Vermont—at an IHS conference that came to be widely recognized as the take-off arbitrary. point for the Austrian Resurgence. There, Murray Rothbard, Kirzner and Ludwig Suppose that Missouri’s largest bank holding company, whose lead bank is in 13 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 14

Kansas City, wanted to acquire a small bank in nearby Blue Springs. The holding intertemporal disequilibrium. I would later learn that Hayek, who was watching the company would press for a definition of the relevant market area that minimizes the Fed in the early 1920s, began work on an NYU Ph.D. thesis on the question “Is the impact of the proposed acquisition. It would argue one of two extremes—that there function of money consistent with an artificial stabilization of purchasing power?”—a would be no change in the market-share figures because the relevant market areas were question that could only be puzzling to the monetarists. so small that the Kansas City bank and the Blue Springs bank were in two different The difference between these two books was a reflection of their competing market areas; or that there would be only a minuscule change in the market-share analytical frameworks. But in each case the analytical framework was not well-defined. figures because the lead bank and the target bank were located in a very large market Friedman (1970) had attempted to set out the differences between himself and the area (the whole state of Missouri) in which many banks competed. The Federal Keynesians by expressing these two sets of ideas in the IS-LM framework. Was this Reserve would usually opt for some middling market-area definition—using rivers Keynesian framework also the monetarist framework? If not, then just what—beyond (despite bridges), county lines, and even highways as market-area boundaries. But I the equation of exchange plus a money-demand equation—was the monetarist don’t recall a case where the change in market share was judged to be significant. The framework? The Austrian analytics seemed to revolve around the intertemporal Fed didn’t bust many trusts. structure of production as depicted by the Hayekian triangle, whose changing shape Evaluating an application always entailed interviewing the CEOs of other small reflects marginal adjustments in the roundaboutness of the economy’s production banks that competed with the target bank. Tellingly, the reactions of the target banks’ activities. Though vital, this little piece of pedagogy, by itself, hardly passed muster competitors were either grave concern or seeming indifference: “How are we supposed as an analytical framework. to compete with the largest bank holding company in the state!?” Or, quite often: “The Dating from the South Royalton conference, my interests in the analytical acquisition is fine with us; we’ll compete”—which really meant that this bank was framework of Austrian macroeconomics grew. Lectures at that conference by Ludwig currently in the negotiation phase with the second largest bank holding company in the Lachmann, though somewhat cryptic, further convinced me that it was capital theory state. While traveling around the Federal Reserveâi™s tenth district for on-site visits that made the difference between the Austrians and mainstream schools. And having (mostly in Missouri and Colorado), I was also reading ’s and listened to the lectures by Israel Kirzner, my interests in market areas and market (1973) in preparation for attending the South Royalton conference. shares were decidedly on the wane. Besides, with only a masters degree, I did not have I had trouble, to say the least, trying to reconcile what I was reading with what I was a bright future with the Federal Reserve. It was time for me to go. I had been reluctant doing. to continue my graduate studies mainly because I did not know which In between applications, I had time to pursue my macroeconomic interests. Did programs might be worthwhile. But I now knew of three possibilities—all suggested the boom during the 1920s have a significant policy-driven component? There was no to me by Rothbard: , UCLA, and the University of Virginia. dispute about there being significant real growth during that decade. But what about Other events and opportunities at the time spurred me on. Sudha Shenoy, whom money growth and its effects on prices and on interest rates—and hence on resource I had met at South Royalton, arranged for me to attend the Hayek-led Mont Pélerin allocation? I juxtaposed two key books giving contrasting answers to these and related Society meetings in September of that year. Those meetings were held in Brussels, just questions, both published in 1963: Friedman and Schwartz’s Monetary History of the three months after South Royalton. And in the following month, Hayek was awarded (1867-1960) and Rothbard’s America’s Great Depression. It became the Nobel Prize for his early work in industrial fluctuations. In November I attended clear that, with minor variation, both books relied on the same data: Friedman and the Southern Economic Association meetings in Atlanta in order to discuss with Schwartz reported the annual growth rate of the money supply for the 1920s and took George Pearson a possible fellowship arrangement. If I was inclined to leave the it to be consistent with macroeconomic stability. Rothbard reported the cumulative Federal Reserve and resume graduate studies, the Institute for Humane Studies, then growth of the money for an eight-year period (1921-1929) and saw it as alarmingly in Menlo Park, California, would accept me as a resident fellow during the summers. high. With that opportunity, I became a short-timer in Kansas City. I did no search for other Clearly, the difference between Friedman and Rothbard lay in their contrasting graduate programs beyond the three that Rothbard had mentioned. But having no interpretations of Federal Reserve behavior during the 1920s. Friedman took the strong desire to live in either New York City or Los Angeles, I headed for constant or near-constant that characterized the decade as evidence of Charlottesville. monetary stability. Money creation was accommodating real growth. Rothbard looked at the effect of this accommodation on interest rates and hence on the intertemporal VI. Virginia: Preparing for an Academic Career pattern of investment. In his judgment, the credit expansion resulted in widespread Virginia’s economics department in the mid seventies was in decline. Jim Buchanan 15 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 16 and had left. Warren Nutter had fallen ill, and the few others to whom Humane Studies in 1977 and 1978 when, as luck would have it, Hayek was in UVa owed its good reputation (for its adherence to the principles of classical residence there, too. After having been occupied with the broader issues of political ) were on the political outs. The department was beginning to turn towards science for more than three decades, Hayek was beginning to think again about the mathematical economics—though not as much so as was the general trend in those issues of money and macroeconomics. He had just published his Choice in Currency years. In the field of macroeconomics, there wasn’t much sympathy for Keynesianism, (1976) and had expanded it into the Denationalization of Money (1976) except in the first-semester core course. That course was taught by a visiting professor Participating in the UCLA Oral History Program, Hayek had reaffirmed his early who was so inept and narrow-minded as to make Keynesian constructions views about the nature of business cycles. And he wrote an inspiring Foreword to monumentally unappealing. and its offshoots (new classicism and rational Gerald O’Driscoll’s Economics as a Coordination Problem: The Contribution of expectations) were considered to be the mainstream and the cutting edge of monetary Friedrich A. Hayek (1977). O’Driscoll, a UCLA graduate and IHS resident fellow, had theory. demonstrated in his dissertation the unity of Hayek’s work. Hayek found the The propensity to mathematize was eroding the Virginia tradition. The math never demonstration satisfying and even moving: “That it seems in principle possible to got in my way, thanks to my engineering background, but I had no inclination to take recast a great part of economic theory in terms of the approach which I had found a purely mathematical approach to economics. Having learned Lagrangian multipliers useful in dealing with such different problems as those of industrial fluctuations and and the like separately from the substantive content of economics had a definite payoff. the running of a socialist economy [is] gratifying to me.... Professor O’Driscoll has That training sequence keeps the mathematics in perspective—which, in many cases, almost persuaded me that I ought to have continued with the work I had been doing in is to say that it keeps the math at bay. In macroeconomics, what often matters most are the 1930s and 1940s rather than let myself be drawn away to other problems which I the institutional arrangements, such as the fact that new money enters the economy felt to be more important.” Hayek was an inspiration for me to finish the dissertation through credit markets and hence impinges in the first instance on interest rates. And and to press on with the research agenda that had occupied him during his early LSE changes in the interest rate have a predictable effect on the pattern of investment—as years. can be demonstrated by those present-value calculations I learned in Engineering Econ. IHS provided opportunities to teach Austrian macroeconomics. Starting the year For me the shining light at Virginia was Leland Yeager, whose monetary of the Windsor Castle conference, IHS ran a teaching conference almost every year—at disequilibrium theory (Yeager, 1997) derives from the pre-Friedman monetarism of the University of Delaware (1976), Mills College of Oakland, California (1977), the Clark Warburton. Yeager taught a course in monetary theory using Don Patinkin’s University of Colorado (1978-1980), and Marquette University (1982, 1984, and Money, Interest, and Prices (1965), a book well anchored in name and in deed to Knut 1986). I was a Teaching Assistant at the Delaware conference and was on the faculty Wicksell’s Interest and Prices (1898). It was the Wicksell-Patinkin connection that at all the others—along with Israel Kirzner, Jerry O’Driscoll, Mario Rizzo, and a inspired my dissertation. Wicksell had called attention to the “cumulative process” that number of guest lecturers. is set into motion by a bank rate of interest held below the market, or natural, rate. I could trace the Wicksellian insights in two different directions—to Patinkin and to VII. Auburn: A Base of Operations Hayek—showing how one direction of development emphasized the sense in which In the late seventies the Department of Economics at Auburn University was in a money is neutral while the other emphasized the inherent non-neutrality of the process building phase. The strategy was to attract low-tech market-oriented economists. The through which the economy adjusts to a monetary expansion. The key difference department attracted me in 1978. “Market orientation,” it turned out, got translated into between the two different directions of development was capital theory—its wholesale “not much macroeconomics.” The department proudly described itself as a place to neglect in Patinkin’s framework and its centrality in Hayek’s. learn low-tech applied microeconomics. In my early Auburn years I taught Principles While in residence at the University of Virginia, I had the good fortune to serve of Microeconomics and History of Economic Thought as well as Business Conditions as a Teaching Assistant to Kenneth Elzinga and Bill Breit, a peerless duo who taught Analysis in the MBA program. But soon enough, as one of the few macroeconomists Virginia’s two-semester sequence of microeconomics and macroeconomics. Their on the faculty, I saw my teaching repertoire narrow to macroeconomics at all performances in the undergraduate classroom, together with Yeager’s performance at levels—principles, upper-level undergraduate, and graduate. the graduate level, were a virtual how-to course for budding academics who In 1981 I took leave from Auburn to spend a semester at New York University as themselves would soon be teaching. a Visiting Fellow. The attraction there was the weekly Austrian Economics Of course, making the transition from graduate student to professor required Colloquium, the active participants including Israel Kirzner, , Jerry actually completing the dissertation. I was able to work on mine at the Institute for O’Driscoll, and Mario Rizzo. It was during that visit that I began writing an article that 17 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 18 eventually appeared as “Time and Money: The Universals of Macroeconomic another—as can be depicted as movements along a PPF. Theorizing” (1984). Capital-based macroeconomics integrates capital theory, which In an encyclopedia entry on the “The Austrian Theory of the ” captures the critical time element in the macroeconomy, with monetary disequilibrium (Garrison, 1997a), I focused on the market for loanable funds to make the key Austrian theory, which identifies the source of macroeconomic problems. Precisely because of distinction between sustainable and unsustainable growth. An increase in saving shifts the time element, disequilibrium affecting the economy’s capital structure can persist. the supply of loanable funds rightward, lowers the rate of interest, and sets the Problems can fester until the disequilibrium begets a crisis and downturn. An aphorism economy off on a steeper growth path. By contrast, credit expansion pads the supply emerged that captures the idea: Capital gives money time to cause trouble. The article of loanable funds, drives a wedge between saving and investment, and sets the is widely cited (in Austrian circles) and has been reprinted in various volumes of economy off on an unsustainable growth path. collected essays. These three simple graphs—the Hayekian triangle, the production possibilities The Ludwig von attached itself to Auburn University in 1983 and frontier, and the loanable-funds market—all came together for me in the classroom at soon enticed Leland Yeager to leave Virginia to become Auburn’s Ludwig von Mises Auburn. They jelled into a capital-based macroeconomic framework that was much Professor. Though critical of those very aspects of the Austrian theory that I have superior to my earlier diagrammatic exposition. The 1984 article lends its title to my always found most attractive, Yeager has been a continuing and significant force in book-length treatment of the issues: Time and Money: The Macroeconomics of Capital shaping my ideas. My research and writing in the 1980s and 1990s can be Structure (2001). The analytical framework of interlocking graphs, first assembled to characterized as a piecemeal approach to resolving the key issues separating the demonstrate the logical coherence of Hayek’s business cycle theory, turned out to have various schools of macroeconomic thought. much broader application—in analyzing the fiscal issues such as deficit finance and In one instance, I collaborated with an Auburn colleague to pit Hayek against reform and in sharpening the contrast between the Austrians’ capital-based theory and Friedman. Don Bellante, who was also my immediate successor as an NYU Visiting Keynes’s labor-based theory. Fellow, is a labor economist with a macroeconomics orientation. He and I had similar views about the disruptive effects of monetary expansion. Our separate strengths were very much complementary—his in critically expositing the dynamics of the Phillips VIII. Capital-Based Macroeconomics on Tour curve, mine in expositing the dynamics of the Hayekian triangle. We conspired to write I took a sabbatical in the fall of 1997 to speed the progress on the book. Coincidentally, an article titled, “Phillips Curves and Hayekian Triangles: Two Perspectives on I was invited to deliver the Ludwig Lachmann Memorial Lecture at the University of Monetary Dynamics” (1988). In terms of both logic and implications, we found the Witwatersrand in , in late August of that year. The trip Austrianism to be superior to monetarism. (This publication represents one of the few to South Africa quickly developed into a lecture tour with stops at the University of instances where co-authoring seemed to work for me. Generally, I prefer to work on Capetown and the Reserve Bank in Pretoria. I used the Lachmann lecture to deal with my own, my aversion to co-authorship being similar to my aversion to teamwork in the the issue of expectations in macroeconomics. This was always Lachmann’s favorite undergraduate engineering labs at the Missouri School of Mines.) topic—and in light of the dominance of rational-expectation models in mainstream Some years later, I put the dynamics of the Hayekian triangle in play in my theorizing, one that had to be addressed head-on. That lecture (Garrison, 1997b) Comment on Friedman’s ‘Plucking Model’” (1996). Curiously, Friedman (1993) had became Chapter 2 in my book. At Capetown, I presented the capital-based framework taken the observed temporal pattern of total output to be a basis for declaring irrelevant to a very receptive audience and put it through its paces in the context of boom and all theories that suggest a cause-and-effect connection between boom and subseqent bust. bust. His critical remarks, explicitly directed at the Austrian theory, would be equally The visit to the central bank in Pretoria, which was arranged by South Africa’s telling, of course, against his own short-run/long-run Phillips curve analysis. Foundation, was an occasion to make the distinction between a Fed-led In another critical article, “The Persistence of Keynesian Myths: A Report at Six boom and a debt-led boom. The economic expansion that began during the Reagan Decades” (1995b), I employed a production possibilities frontier (PPF) to highlight the administration was spurred on by a Treasury that was borrowing money rather than by essential difference between Keynesian and Austrian constructions. I discovered later a central bank that was creating money. Still, the boom was an unsustainable one, that Abba Lerner (in Colander and Landreth, 1996) had made the same distinction though the dynamics were different. Investments become excessively speculative early on: For Keynes, consumption and investment are magnitudes that move up and rather than excessively roundabout. The asked me to write up down together, their path of possible movements intersecting the PPF; for the classical the lecture for publication as a monograph. My Chronically Large Federal Budget economists, including Hayek, those two magnitudes can be traded off against one Deficits: The American Experience (1998) appeared in print just as the Clinton 19 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 20 administration’s Fed-led boom turned the budget from deficit to surplus. The timing Bibliography dampened interest in the monograph, but the arguments were incorporated into Chapter 6 of my book. For me, the most satisfying experience came by way of an invitation to be the first Bellante, Don and ”Phillips Curves and Hayekian Triangles: Two Perspectives on Hayek Visiting Fellow at the London School of Economics. The visit, during May/June Monetary Dynamics,” History of 20(2), 207-234. 2003, was arranged by Toby Baxendale, a London businessman, and was sponsored by LSE and the Mises Institute. The highlight of that five-week visit was a Böhm-Bawerk, Eugen von. (1959 [1984, 1989, and 1909]) , 3 well-attended public lecture in LSE’s Old Auditorium. Seventy-two years after Hayek vols., South Holland, Ill.: Libertarian Press. gave the lectures that became Prices and Production, I was able to give a lecture that was inspired by that book, telling the story of the business cycle with the aid of a Caldwell, Bruce J. (1998) “Why Didn’t Hayek Review Keynes’s General Theory?” capital-based analytical framework and putting Keynes and Hayek head-to-head in a History of Political Economy, 30(4), 545-569. way that had not been done before. Cohen, Ali J. and G. C. Harcourt (2003) “Whatever Happened to the Cambridge IX. Prospects and Perspective The Mises Institute has given me many opportunities Capital Theory Controversies?” Journal of Economic Perspectives, 17(1), 199-214. to fine-tune the pedagogy in presenting the Austrian theory of the business cycle and, more generally, capital-based macroeconomics. Starting in the mid 1980s with a pilot Colander, David and Harry Landreth (1996) The Coming of Keynesianism to America: program in Auburn, the Institute has organized teaching conferences—first at Stanford Conversations with the Founders of . Brookfield, Mass.: Edward University and Claremont University in California and, since the mid 1990s, at Auburn Elgar. University. Those conferences, as well as the Institute’s annual Austrian Scholars Conference, have been important in developing the theory and pedagogy that appears Dolan, Edwin, ed. (1976) Foundations of Austrian Economics. Kansas City: Sheed and in Time and Money. Similar benefits have come from my participation in the teaching Ward. conferences organized by New York University and, more recently, by and held each year at the Foundation for Economic Education in Friedman, Milton (1970) “A Theoretical Framework for Monetary Analysis,” in Robert Irvington-on-Hudson, New York. Gordon, ed., ’s Monetary Framework: A Debate with His Critics, Time and Money continues to be a source of ideas for development for me and for Chicago: University of Chicago Press, 1-62. others. I have become intrigued with the puzzles of the associated doctrinal history, such as reconciling the concepts of “Forced Saving and Overconsumption in the ______(1993) “The ‘Plucking Model’ of Business Cycle Fluctuations Revisited,” Mises-Hayek Theory of the Business Cycle” (2004). And I note with some satisfaction Economic Inquiry, 31(2), 171-177. that the term capital-based macroeconomics seems to have found its way into the lexicon of macroeconomics as a more substantive name for analytical framework that Friedman, Milton, and Anna Schwartz (1963) A Monetary History of the United States, was once identified only by its country of origin. 1867-1960, Princeton: Princeton University Press. The story told in this essay, though involving a roundabout progression, seems to entail a greater linearity and singularity of purpose than was ever actually evident Garrison, Roger (1978) “Austrian Macroeconomics: A Diagrammatical Exposition,” along the way. And although it is true that, when in an academic frame of mind, my in Louis M. Spadaro, ed., New Directions in Austrian Economics, Kansas City: Sheed, thoughts are dominated by time, money, capital, and interest, these macroeconomic Andrews, and McMeel, 167-204. concepts and the theories we can build with them are kept in perspective by more worldly matters—by the memory of my parents, by conversations with my brother, and ______(1979) “Comment: Waiting in Vienna,” in Mario J. Rizzo, ed., Time, by spending time with my twelve-year-old son Jim and with my wife Karen, who is Uncertainty, and Disequilibrium, Lexington, Mass.: D. C. Heath and Co., 215-226. also my best friend. ______(1984) “Time and Money: the Universals of Economic Theorizing,” Journal of Macroeconomics, 6(2), 197-213. 21 forthcoming in The American Economist A Roundabout Approach to Macroeconomics 22

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